Good Debt vs. Bad Debt (Because Some Debt Is Actually Good)
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"Debt is the slavery of the free," Publilius Syrus, a Latin writer.
"Wars in old times were made to get slaves. The modern implement of imposing slavery is debt," Ezra Pound, an American poet and critic.
For millennia, debt has been portrayed as a necessary evil, something you may have to take on if you'd like to be able to afford the finer things in life. But for others, debt may be an endless pit. So, imagine my surprise when I discovered that there's something called "good" debt, which went against personal finance teachings. But as I dug deeper, a clearer picture began to emerge. Not all debt is bad; you should still borrow money if it is affordable and will help you achieve your financial goals. The key is to borrow money only when necessary and avoid taking on excessive debt that you cannot afford to repay. However, ultimately your financial situation may still compel you to turn to debt.
In this article
What is good debt?
Instead of going into examples of good debt right off the bat, there's an easier way of explaining what exactly good debt is: any kind of debt that has future value and increases your net worth is considered good debt. Put another way, good debt is a type of debt that positively affects an individual or society. This debt helps people meet their needs, improves the economy, and strengthens social institutions.
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Common types of good debt
Many types of good debt benefit the borrower and the lender. Examples of good debt include mortgages, student loans, and business loans.
Mortgages
Mortgage debt is among the most common types of good debt. A mortgage is a loan that you take out to purchase a home. When you take out a mortgage, you make monthly payments to the bank to repay the loan. A mortgage can be a useful tool that can help you purchase a home if you do not have enough cash on hand to cover the down payment. Keep in mind that your mortgage will be secured against your home, which means that if you do not make your payments, the bank can take the home away from you.
Business loans
Most businesses rely on bank loans to help them meet their business expenses. The advantage of taking out a business loan is that you can spread the cost of your business expenses over time instead of having to pay them all at once. This allows you to free up some of your working capital which can be used for other business activities. Regardless of how you use this loan, a business helps stimulate the economy, and that's why it's considered good debt.
Student loans
A student loan allows you to borrow funds to cover the cost of your education as long as you make your repayments in full and on time. This type of debt allows you to receive a higher education if you can't afford it on your own. In theory, you get a student loan, land a good job (and participate in the economy), and repay the money. In reality, however, things are much different. Cashing in your degree for a job that pays enough to repay the money is not guaranteed, and most people spend years making student loan payments. Student loans can be tax-deductible as well.
What is bad debt?
It is important to keep in mind that not all debt is good. Bad debt has negative effects on individuals and society as a whole. Examples of bad debt include credit card debt, payday loans, and personal loans.
Common types of bed debt
Credit cards
Credit cards are one of the most common forms of bad debt today. Credit cards allow you to borrow money in exchange for monthly repayments on your balance. One of the biggest advantages of using a credit card is that you don’t have to go through the trouble of applying for a loan from a bank. Instead, you simply use the credit card as a payment method when you need to make a purchase.
However, it is important to keep in mind that credit cards are very expensive to use. Unlike other forms of borrowing, there is no set amount that you have to pay each month. If you cannot pay your balance in full by the due date, you will be charged interest on the amount you owe. This means you will pay more on your credit card than you originally borrowed. On top of that, a late payment may end up on your credit report and ruin your credit score if the credit card company decides to report the debt to the credit bureaus. This will result in a lower credit score, and any future debt will incur high-interest rates.
Personal loans
Personal loans are unsecured loans used by individuals to pay for things such as home renovations or weddings. You are not required to put up any collateral to obtain a personal loan. However, rates on personal loans can vary wildly, and you can expect to pay a much higher interest rate if you have bad credit.
Payday loans
Another example of bad debt would be a payday loan because they are very expensive compared to other types of loans. Many people also use payday loans to pay for everyday expenses such as groceries and utility bills. Payday loans are basically short-term loans that allow you to borrow small amounts of money for a short period of time. While these loans might seem convenient, they are very costly, so you should avoid using them if possible. Payday lenders have long been accused of predatory lending, and the Federal Trade Commission has gone after several such lenders.
If you default on a payday loan, you will have to pay additional fees and make additional interest payments. This will cost you far more than the original amount you borrowed, making it a very expensive form of debt.
Related: 2022's Best Installment Loans
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How to repay debt
Having a large amount of debt can be very damaging to your finances. The best way to deal with debt is to find a way to reduce it as quickly as possible so you can become debt free. If you are struggling to deal with your debt, several options can help reduce the burden and make it more manageable. Here are a few debt management strategies you can utilize:
- Debt snowball method: Ever seen a snowball roll down a hill? It starts off small and slowly gains momentum, and grows in size. That's how this debt-reduction strategy works. You make minimum payments on all your debts, but you make a little extra each month on the debt with the smallest balance. Once you knock that out, you move to the next smallest debt, and so on.
- Debt avalanche method: This repayment strategy stipulates that you list all of your debts. Then, come payment time, make the minimum payment on each debt, but pay extra on the debt incurring the highest rate. This ensures you get rid of the most expensive, higher-interest debt first.
- Debt consolidation: You can also consider a debt consolidation loan to help you manage your debts more effectively. This will allow you to lump different types of debt together into one easy-to-manage payment, which will help you to reduce your outgoings. Many people also find that a debt consolidation loan helps them to pay their debts off faster and is easier to manage than repaying multiple smaller debts separately.
- Create a budget: It can be helpful to create a budget to determine how much you can afford to pay off each month and compare this against your total debt. You should also look for any ways to make a little extra money as this can be used to help repay your debts more quickly.
- Debt relief companies: These companies can often help negotiate more affordable payment terms with your creditors and can significantly reduce the total amount of your debt. However, this option can take around two years before you become debt-free. Consultation is free in most cases, but debt relief companies take a portion of the debt they helped you with as payment.
- Balance transfer cards: If you're currently being charged a higher interest rate on a credit card, you can transfer the balance to one of the many cards offering a promotional 0% APR, or a low-interest rate. This can dramatically speed up your journey to becoming debt free.
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The bottom line
Bad debts are forms of debt that are expensive and damaging to your finances, while good debts are, well, good for you because they have future value. Mortgages, student loans, and business loans are some of the most common types of good debt. And the most common types of bad debt include credit card debt, payday loans, and personal loans.
It is important to avoid taking on too much debt as it can hurt your finances. Being debt free has several benefits, including greater financial stability and the ability to save money for the future. Incorporating a debt repayment strategy into your budget can help ensure you stay in control of your finances and save money in the long run.
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Writer
Jasir Jawaid is Joy Wallet's Assistant Editor. He has more than 13 years of experience as a journalist covering Wall Street, equities, financial policy and regulation, and cryptocurrency and blockchain.
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